Geopolitical risks are changing and rising. The energy sector will be in the crosshairs

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Global politics is entering uncharted waters. The post-Cold War liberal world order crafted by the US, Europe and their allies, which provides the framework for multinational enterprise, is increasingly threatened by both external and internal challengers.

Externally, major powers are promoting alternate visions of world order. A new global economy has emerged as a result of rapid growth in the developing world, where large economies like China and India, or regions like sub-Saharan Africa and Southeast Asia, lead trade and investment opportunity. Having benefited substantially from globalisation, the major emerging markets are now pitching themselves as the custodians of world trade, environmental protection, and international cooperation.

Internally, Western political populism is questioning the viability and durability of the liberal world order. The recent success of nationalist, isolationist and protectionist movements in the US and Europe, often fringed with xenophobic factions, has depleted political support for global trade, foreign aid, and costly military commitments. Most significantly, at his inauguration, US President Donald Trump baldly stated a principle of "America First" in global affairs. European populists and eurosceptic movements are seeking to replicate this philosophy in a number of pivotal elections in 2017.

While post-Cold War assumptions are fading away, the contours of the next world order are still being negotiated. We believe nationalism, global power vacuums and proxy conflicts will continue to drive geopolitics in 2017 and beyond. Global public goods and win-win strategies are being replaced by nationalist projects and zero-sum calculations. Bilateral transactions are increasingly being preferred to multilateral cooperation. Strategic uncertainty is the order of the day. The global energy system is obviously not immune to these trends. Specifically, four issues are important in assessing the outlook for oil and gas in the emerging world order.

First, trade disruption could have negative economic consequences for energy markets and investment. Most obviously, a major US trade war with China could severely damage both economies, which combined consume nearly one-third of primary oil and gas energy. Needless to say, a slowdown would also have negative global impacts, particularly for trade-dependent Asian economies. Similarly, Brexit and the prospect of further threats to EU cohesion and trade relations in 2017 could harm a regional economy only just emerging from the 2008-09 global financial crisis. Even in the absence of major trade disruption, the relatively strong US economy increases the likelihood of higher inflation and interest-rate hikes, which—by strengthening the dollar—would weigh on commodity prices and potentially inject renewed volatility into emerging markets.

Trade disruption could have negative economic consequences for energy markets and investment

Second, US economic policy will promote domestic oil and gas development, thereby continuing to shape world markets. Thanks to the evolution of hydraulic fracturing, the US has supplanted Opec as the decisive global oil producer and emerged as a strategic liquefied natural gas supplier to Europe. The US administration is now proceeding with steps to deregulate aspects of domestic oil and gas production, particularly around environmental safeguards, which will help sustain production levels. Meanwhile, having lost a strategic gamble on market share, Opec's efforts to reassert supply management and market control are likely to remain confounded by internal competition and regional conflicts. In any event, putting a floor under prices also serves to bolster US and other non-Opec production.

Third, major conflict risks—though still low-persist in a number of strategic locations. Especially concerning is the increasing regional competition and proxy warfare between Iran and Saudi Arabia, which pose security threats to the Hormuz and Bab el-Mandeb straits, used for a large proportion of oil and gas shipments. The geopolitical fallout from the conflict in Syria and Iraq is likely to further aggravate Middle East tensions in 2017, as is a US administration hostile to the Iran nuclear accord. Sabre-rattling in the South China Sea is also likely to increase as the US pursues a more confrontational approach to China, increasing the likelihood of actions, accidents, and miscalculations that threaten to disrupt shipping along critical sea lanes. (As a side note, keep an eye on the mounting threat from North Korea to regional and global security.) Friction between China and Russia in Central Asia is also likely to rise, as China pursues its "Belt and Road" trade and energy integration strategy in the region. Finally, elevated tensions between Russia and Europe are likely to persist, not least as the US pursues another "reset" in relations with Russia.

Infrastructure showdown

Acute security threats to energy infrastructure from state and non-state actors are also increasing. On the one hand, the collapse of Islamic State-controlled territory in Syria and Iraq is likely to further fragment the global jihadist movement. In particular, it will increase the intent of IS and its affiliates, as well as the al-Qaida network, to carry out high-impact attacks in retaliation for setbacks and to retain or gain influence among Islamist extremist groups. While few recent attacks have directly targeted energy infrastructure, it remains a strategic economic target for both groups, particularly in the Middle East.

On the other hand, energy assets, among all kinds of critical national infrastructure, are in the cross hairs of cyber-enabled threat actors, whether hostile states, ideological hacktivists, or sophisticated criminal groups. On top of the generic trend of expanding cyber threats, the looming menace to critical infrastructure appears to reflect three relatively recent developments.

First, cyber operations are increasingly normalised as tools of statecraft, as opposed to simply intelligence gathering, with a number of proof-of-concept attacks on infrastructure—such as disruptions of Ukraine's power grid-appearing to serve as geopolitical threats. Second, the move from clandestine to overt (if not always attributable) cyber aggression suggests decreasing restraint among key players, particularly Russia and the US. (A number of attacks on energy infrastructure have coincided with geopolitical disputes.) Finally, the disclosure of advanced cyber weapons and the targeting of internet of things devices (the connection of everyday devices to the internet) is augmenting the capability of all malicious cyber actors, from criminal groups to extremists to hacktivists.

For the energy sector, as for everything else, the foundations of the post-Cold War era are increasingly unstable. The rising tide of Western populism and competitive nationalism threatens to wash away key assumptions underpinning multinational business models, including economic liberalisation, regulatory convergence, and political stability. Key variables in the outlook for 2017, from US trade policy to European elections to China's leadership transition, are still undetermined but likely to be decisive. Looking ahead, a wider range of plausible scenarios, coupled with a more diverse and diffuse range of threats, will make risk prioritisation more difficult.